Question

In: Finance

Subject Merger and Acquisition 1. What do research studies say about the premiums paid and the...

Subject Merger and Acquisition

1. What do research studies say about the premiums paid and the event returns from international M&A activities? What are the reasons provided in the literature behind the premiums paid?

Solutions

Expert Solution

An acquisition premium is the difference between the actual price paid to acquire a company and the estimated real value of the acquired company before the acquisition. It is often recorded as "goodwill" on the balance sheet.

Let's assume Company XYZ wants to acquire Company ABC. If Company ABC is worth $15 per share but Company XYZ offers $20 per share, this means Company XYZ is willing to pay a 30% acquisition premium ($20 - $15)/$15.

Although acquisition premiums can run quite high, not every company pays an acquisition premium for a target. Furthermore, not every company intentionally pays an acquisition premium.

For instance, if Company XYZ offered $20 per share when ABC was trading at $20, but then ABC shares fell to $10 per share before the acquisition was complete, Company XYZ would find itself paying a 50% premium. In most cases, however, this dramatic drop in share price would probably cause Company XYZ to withdraw its offer.

The size of the premium often depends on various factors such as competition within the industry, the presence of other bidders, and the motivations of the buyer and seller.

Most companies pay acquisition premiums for two reasons: (1) to ensure that the deal gets closed and (2) because they feel that the synergies generated by the combined entities will be greater than the total price paid for the target.

The decision of how much to pay for an acquisition target involves professional judgment beyond that which comes from evaluating spreadsheets. After all, even if paying an acquisition premium benefits the target's shareholders, paying a higher acquisition premium puts more pressure on the acquiring company to produce the results its inherited shareholders will expect.

Acquisition premiums are generally measured by taking the difference between the stock price

paid to a target firm, and the price of the target's stock at some point in time before the deal, divided by the target's Mock price before the deal. Paying a premium indicates that the value of the large company is higher to the acquirer than it is to its original owner(Diaz & Azofra, 2009). This higher value can come from factors such as economies of scale and scope, diversification leading to risk reduction and a higher market power of the combined institutions. These premiums can be significant, Betton et al. (2008) for example report that between 1980 and 2002 the average premium paid for an American target is 48% of the market value of the target before the bid.

Cal-fen (2011) argues there are four main theoretical explanations why premiums are paid in M&A. The author mostly uses these five explanations to explain overpayment, however to get good understanding of the l'undamental idea of why a premium is paid they will be described way of sharing the synergy created by merging the two entities. Synergy means that the two firms

merged would profit from factors such as economies of scale and scope, where the combined effect is larger than the sum of the separate effects. In constructing an M&A deal, a synergy value is determined and the acquirer shares some of this synergy value with the larget in the form of shortly.

Firstly, Cai-len mentions the synergy theory. Monden (2010) describes the premium as premium puid in the larget stock price. This sharing occurs because there is double information asymmetry (Hansen, 1987).

Secondly, the signal theory as described by Baron (1983) offers a more tactically oriented explanation for paying higher premiums. Parties making a bid might use the high amount to discourage other bidders from getting involved. Furthermore, a high bid might induce a quick closing of the deal saving the acquirer both time and money.

Third, agency theory as described by Jensen and Meckling (1976) describes how management of an acquiring company indulges in opportunistic behavior. This might lead to 'empire building' in which managers attempt to maximize their reputation as leaders of giant conglomerates (Hope & Thomas, 2008). This explains why they would pay a premium to overtake another firm, to serve their self-interest.

Finally, behavioral theory explains how premiums might be driven upward because managers suffer from hubris (Malmendier & Tate, 2005). Managers from the acquiring firm might be overoptimistic concerning the profits from the joint operation. By looking at the determinants of premiums, this thesis will investigate premiums from

the perspective of synergy theory. Whereas all four theories mentioned before help to understand why premiums are paid, the synergy theory is best suited to better understand which ex ante factors are taken into account when determining a premium in actual deals. The other theories help explain ex post why a premium paid might have been incorrect based on results of the merged

company. When an offer price is determined, it is unlikely that acquiring management factors in its own overconfidence or opportunistic incentives. They will however, model future profits and base the premium they pay on the amount of profits they are willing to share with target company

shareholders, as is done by Garzella and Fiorentino (2014).


Related Solutions

Subject Merger and Acquisition Discuss the 10 forces driving cross border merger?
Subject Merger and Acquisition Discuss the 10 forces driving cross border merger?
Merge & Acquisition subject You will investigate a recent merger or acquisition. You will prepare a...
Merge & Acquisition subject You will investigate a recent merger or acquisition. You will prepare a written project (2500 words). Analyze a recent merger or acquisition that has been successful or unsuccessful. In order to identify the causes and effects of the particular acquisition movement. The acquisition deal may be closed, still pending, or canceled. This acquisition could be a success or a fail. The objective is to select different acquisitions. It requires you to approach a real situation. You...
Subject Merger and Acquisition What is the effect of such amendments on firm’s stock price based...
Subject Merger and Acquisition What is the effect of such amendments on firm’s stock price based on empirical evidence? What are the financial characteristics that make a firm vulnerable to takeover?
find an article about a merger or acquisition that was announced within the last month. you...
find an article about a merger or acquisition that was announced within the last month. you should include a brief summary of the deal, along with your thoughts on the deal. To help you get started, here are some issues to consider: Is this a good deal (i.e., is this deal likely to create value for the acquiring firm)? What synergies does the deal create? Are these synergies realizable? What is the catalyst for the deal? Why is the deal...
find an article about a merger or acquisition that was announced within the last month. you...
find an article about a merger or acquisition that was announced within the last month. you should include a brief summary of the deal, along with your thoughts on the deal. To help you get started, here are some issues to consider: Is this a good deal (i.e., is this deal likely to create value for the acquiring firm)? What synergies does the deal create? Are these synergies realizable? What is the catalyst for the deal? Why is the deal...
What does research say about consumer responsibility during recall situations? And, what's a consumer to do,...
What does research say about consumer responsibility during recall situations? And, what's a consumer to do, when the manufacturer has no remedy?
What are 3 challenges for executing a merger or acquisition? List, explain, and provide 1 example...
What are 3 challenges for executing a merger or acquisition? List, explain, and provide 1 example (total).
1. What are narrow window studies and wide window studies in accounting research, and what are...
1. What are narrow window studies and wide window studies in accounting research, and what are they used for respectively. 2. List Fair value hierarchy according to IFRS 13, ASC 820-10
research a merger/acquisition/restructuring article either in the Wall Street Journal or off of the internet. You...
research a merger/acquisition/restructuring article either in the Wall Street Journal or off of the internet. You will need to read and understand the article to the best of your ability, and translate this understanding into a one page executive summary. In your summary you will need to discuss the business valuation principles within the article, and develop an opinion to agree or disagree with the tone of the article.
1-how i can know what the financial reporting implications of the merger/acquisition that a company follow...
1-how i can know what the financial reporting implications of the merger/acquisition that a company follow (from where i can get this information)? for example : what the implications of the merger/acquisition that Shire PLC follow to merg with Baxalta ? 2-what are direct acquisition cost (how i can identify them)?List the components of the direct acquisition costs NOTE :all these question related to the merger of Shire and Baxalta
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT